Minimise your tax outgoings by structuring your salary intelligently

Salary is something paid by the employer to an employee in lieu of services provided to the organisation as per the terms of the employment agreement. Individuals receiving salary/wages are required to pay tax on any income above the exempted threshold. The salary received by an employee is also impacted by various deductions, such as statutory contributions and tax deducted at source (TDS). However, an employee may be able to increase his/her take-home salary by means of an intelligent salary structure and efficient tax planning.

Salary comprises various components aimed at meeting the defined requirements of employees. Deductions from the salary would include contributions to the superannuation fund, which is essential to meet post-retirement financial needs. Tax deductions are also available on contributions to statutory funds as well as some of the other components.

Difference between CTC, Gross salary, and Net salary

Cost to Company (CTC) is the term used by organisations to determine the cost involved in retaining an employee. It includes the salary, perks, incentives, medical insurance premiums, bonuses, employer’s contribution to the statutory funds (EPF, ESI) etc. It is therefore inclusive of cash, non-cash, and statutory benefits.

Gross salary is the salary payable to an employee for services rendered. It excludes the employer’s contribution to statutory funds and other non-cash benefits and inclusions. However, the employee’s contribution to statutory funds and tax liability are included.

Net salary is the actual take-home salary available to the employee. It is calculated after making due deductions towards EPF, ESI, professional tax (if applicable), and TDS. Salaried individuals are also required to make a contribution towards social security benefits such as contribution to EPF (Employees’ Provident Fund) and ESI (Employees’ State Insurance).

Main Components of salary and tax implications

Basic: It is the base or the primary component of the salary. The contribution to statutory funds is included in this. The basic component is a fixed part of the salary or compensation structure. This is fully taxable after deducting the EPF contribution (see Notable deductions).

Dearness Allowance (DA): As the name suggests, it’s an allowance paid to combat the rising cost of living. However, it is not mandatory for an organisation to pay DA. DA is also taken into consideration while calculating the contribution to statutory funds. It features as a prominent component of the salary for government and Public Sector Undertaking (PSU) employees. This is fully taxable after deduction of EPF contribution (see Notable deductions).

Allowances: Allowances are generally provided in lieu of DA in the private sector; this does not attract contribution to statutory funds, thereby allowing individuals a higher take-home salary. These allowances are fully taxable.

Common types of allowances

1. Conveyance allowance: It is paid towards travel expenses incurred by an individual while commuting daily to office. Allowance up to Rs. 19,200 was exempt from tax till Financial Year 2017-18. However, no such benefit is available from FY 2018-19 and this is now fully taxable.

2. House rent allowance (HRA): HRA is provided to employees for their accommodation expenses. The allowance is eligible for tax deduction in case one is staying in a rented apartment. Tax deduction available for HRA has been discussed in the tax planning section below.

3. Leave travel allowance (LTA): LTA is paid to cover the cost of long-term travelling incurred by employees. The organisation may provide a fixed monthly allowance. Tax benefit may be claimed on submission of travel bills.

4. City compensatory allowance: This is paid keeping in mind the higher cost of living in metropolitan and urban areas. It is paid to meet the higher expenses incurred for staying in such cities. This is fully taxable.

5. Special allowance: Paid to an individual to adjust the salary so that the gross salary is raised. This is fully taxable.

6. Children’s education/Hostel expense allowance: Allowance may be paid to meet children’s education; such allowance is eligible for deduction of Rs. 1200 per annum per child, subject to a maximum of two children. In case the child is staying in a hostel to complete his/her education, there is an additional exemption up to Rs. 3600 per annum for each child, subject to a maximum of two children. Tax deduction available has been discussed in the tax planning section below.

7. Uniform allowance: This may be paid to employees who are required to wear specific uniforms to perform their duties. The allowance is paid to maintain the upkeep of uniforms. Tax deduction is available for expenses incurred in such upkeep.

8. Bonus/ex gratia: This is paid to recognise the contribution of the employee towards the success of the organisation. The amount may be paid quarterly or annually. This is fully taxable.

9. Daily/Tour allowance: Daily allowance is provided for business tours by employees for official assignments set by their organisations. Tax deduction is available on actual expenses incurred.

Non-cash components exempted from tax

a. Food coupons: Food coupons given to employees are exempt from tax. The Income Tax Act does not mention any restriction on the number of meals, however, the organisation have to keep it within justifiable numbers. However, companies, in general, restrict it to a maximum of 2 meals a day for 8-9 hours schedule. Since anything in excess may draw clarification. Valuation of Food Coupons is normally in the range of Rs. 1,000-Rs 2,000, which supports 2 meals a day provision.

b. Gift vouchers: Gift vouchers up to Rs. 5000 received from the employer are also exempt from tax.

Reimbursement of expenses

They may not form part of the salary, but the following expenses may be reimbursed by the employer according to the employment agreement or as per company policy and practices.

Telephone/Mobile: Mobile and landline bills may be reimbursed by the organisation in case the same is used for official work. The actual bill or an amount fixed by the organisation for such expenses is reimbursed. This reimbursement is tax-exempt.

Books and periodicals: Purchase of books and periodicals related to office work may also be claimed as reimbursement on submission of bills. This is again exempted from tax.

Car Allowance: Tax liability on the car allowance is based on the purpose for which the vehicle is used. If a vehicle is used solely for the official purpose, the expenses reimbursed are not taxable. However, the employer should maintain a complete record of such expenses incurred.

However, If the vehicle is used for official as well as personal purpose irrespective of a car being owned by the employer or employee. Following method is adopted to calculate the Tax Implication.

Total Amount Reimbursed by the Employer

XXX

Less: Amount Specified as per the Income Tax Act based on Engine Capacity*

1. Employees’ Provident Fund (EPF): Employees have to contribute 12% of their Basic salary + DA to the EPF on a monthly basis. Individuals with a salary above Rs. 15,000 per month have the option to opt out, or one may cap their contribution to a maximum of Rs. 15,000 of the salary (Rs. 1800 contribution to EPF). Employers are required to contribute an equal amount to the fund. However, out of the employer’s 12% contribution, 8.67% is deposited to the EPS, while the remaining goes to the EPF Fund.

Employers also have to pay administrative charges of 0.5% for EPF and 0.5% towards employees’ deposit linked insurance fund (EDLI). Employees’ contribution to EPF is eligible for tax deduction under Section 80C of the Income Tax Act up to a maximum of Rs. 1,50,000.

2. Employees’ State Insurance (ESI): ESI is the medical insurance benefit available to employees with salary/wages up to Rs. 21,000. ESI entitles employees and their dependents to free medical treatment in ESI hospitals across the country. The employer contributes 4.75% while employees have to contribute 1.75% towards the ESI Fund.

3. Professional tax: This is levied by the state where the business is situated and the employee is employed. The maximum tax payable is Rs. 2500 based on the income slab of an individual. However, not all states levy professional tax. This amount is exempted from taxable income.

4. Medical premium: Individuals not covered under ESI may be required to contribute to the group health insurance cover provided by the organisation. The share of premium will be based on the extent of cover provided under the plan. The contribution towards medical premium is also eligible for deduction under section 80D up to the limit of Rs. 25,000. Additional Deduction of Rs. 25,000 is available on medical insurance premium paid for parents (father/mother), the deduction goes up to Rs. 50,000 in case the parent's age is above 60 years.

5. Tax Deducted at Source (TDS): TDS is deducted on the income as prescribed under the Income Tax Act.

Other tax-saving options for individuals

Employees’ Provident Fund (EPF): As mentioned earlier, contribution to EPF is eligible for deduction under Section 80C of the Income Tax Act. The maximum deduction available is Rs 1,50,000. Currently, EPF offers 8.55% interest on contributions.

Voluntary Provident Fund (VPF): Contribution to EPF can also be made on a voluntary basis by an employee. In addition to the 12% statutory deduction, individuals may request the employer to contribute the entire remaining 88% of the Basic to EPF if they wish. However, employers are not required to match such voluntary contributions.

National Pension Scheme (NPS): NPS is a retirement benefit plan launched to strengthen social security for Indian citizens. Individuals may claim deduction up to Rs. 50,000/- under Section 80 CCD (1b) on investments in NPS and Atal Pension Yojana (APY). This deduction is over and above that available under Section 80C.

Contribution made by the employer to National Pension Scheme (NPS) is also allowed as a deduction under Section 80CCD(2). This deduction does not have a monetary restriction, but the total deduction claimed for the amount contributed by the employer should not exceed 10% of your salary. This deduction is beyond the limit of 80C.

House Rent Allowance (HRA): HRA is eligible for deductions if one stays in a rented apartment. The tax deduction is allowed under Section 10(13A), as the least amount of the following three conditions:

Actual HRA received as part of the salary

40% of Basic + DA (50% of the salary if the rented property is in a metro city, i.e. Mumbai, Delhi, Chennai, or Kolkata)

Actual rent paid less 10% of salary (Basic + DA)

Children’s education: As mentioned earlier, deductions are available for expenses incurred for children’s education. Furthermore, tuition fees paid to school, college, or university are also eligible for deduction under Section 80C. The deduction is available for a maximum of two children.

Standard deduction: Salaried individuals get a flat benefit of Rs 40,000 as standard deduction. This is provided in lieu of benefits under conveyance allowance and medical reimbursements. This is applicable from FY 2018-19.

Amritesh is an experienced professional in the fields of HR and Finance. Currently, working as HR Consultant and is the Founder of Wealthtech Speaks Blog. Previously, he has been associated with one of the Top IT Company in India. He holds dual masters degree, MBA (HR) & M.Com (Finance). He has also undergone Executive Human Resource Program (EPHRM) from IIM-C and CS (Exe) from ICSI respectively.

Disclaimer: This article is intended for general information purposes only and should not be construed as investment or tax or legal advice. You should separately obtain independent advice when making decisions in these areas.